This article from NatWest reports that fraud costs UK businesses around £190 million annually with about 40% of that figure due to employee fraud, including payroll fraud. Payroll fraud basically involves the theft of business funds via the payroll processing system. In the majority of instances that means that someone within the company is using their position to defraud their employer. Payroll fraud is a significant fraud risk to all businesses, and every company needs a proactive plan to deter and detect it in the workplace.
What are some of the most common forms of payroll fraud?
Timesheet fraud is one of the most common forms of payroll fraud. It occurs when an employee claims to have worked more hours than they actually have and then gets paid for those unworked hours. It might involve making false claims on a physical timesheet, or could be done by clocking on and off at different times to those actually worked in environments where payments are based on those records (perhaps by getting an accomplice to do it on their behalf).
Other forms of payroll fraud include expenses fraud when an employee overstates a claim in order to get some extra money back. Ghost employee fraud happens when a fake employee is created on a system (or an employee who has left stays on the payroll) and payment is made to ‘their’ bank account. Commission or bonus fraud can occur when an employee over-exaggerates sales targets reached in order to gain larger payments. And this isn’t an exhaustive list.
Whatever form of payroll fraud it might be, in many cases it won’t be for a single large amount as this would be easier to spot. Instead payroll fraud is often carried out over a longer period, for small amounts at a time that slowly build up.
The Covid pandemic introduced additional payroll fraud risks
Fraud experts have highlighted that the Covid pandemic has created new opportunities for payroll fraud. This Policy Exchange report highlighted worries that the irregular circumstances in which NHS employees were suddenly having to work, combined with the sudden increased complexity of payroll, could create an environment where payroll fraud might flourish, thanks to issues like fraudulent claims about hours worked, or multiple salary entries.
And there have been other issues connected to the pandemic; the emergency introduction of the furlough scheme presented opportunities for those people so inclined to try to take advantage. In some cases, this might be down to the employer deliberating acting to try to profit from the situation but in some cases, it might be an act of payroll fraud that the employer is not aware of.
HM Revenue and Customs (HMRC) is taking steps to identify cases of furlough fraud and employers could face the possibility of finding themselves under the spotlight because of an employee’s actions.
Getting the balance right
Clearly, employers must be vigilant in combatting business fraud. However, there is a fine line between implementing a payroll fraud prevention strategy and cultivating a work environment where staff feel they are constantly being watched.
As research has demonstrated, that is not good for staff morale and could create an atmosphere of mistrust. According to the CIPD ( the Chartered Institute for Personnel and Development), if employees feel they are being closely monitored, it could affect the psychological contract between them and their employer. Employees will tend to be more negative about work, potentially damaging job satisfaction, their sense of commitment, wellbeing, productivity and performance.
So there has to be a balance found between an excessively policed business and a set-up where employees can get away with fraud. Make sure employees understand the reasons for payroll fraud prevention policies and procedures – most will appreciate why a company has to minimise the risk.
How to detect payroll fraud
Detecting payroll fraud is crucial for maintaining the financial integrity of your business. Effective payroll management must involve robust fraud detection strategies that allow employers to spot discrepancies early. By implementing the following measures, companies can significantly improve their payroll security and reduce the risk of fraud in company operations:
- Regular Payroll Reconciliations
Conduct regular reconciliations between payroll records and actual payments made. This practice helps in identifying any discrepancies that may indicate internal fraud.
- Cross-Department Employee Detail Verification
Cross-check employee details across different departments to ensure there are no duplicates, errors, or ghost employees on the payroll. This extra layer of verification can prevent fraud in company operations, such as the creation of fake employees or the continuation of payments to employees who have left.
- Utilising Payroll Security Measures
Implement strong payroll security measures, such as secure access to payroll systems, regular updates of passwords, and restricted access to sensitive information. These steps help in preventing unauthorised access and reducing the likelihood of internal fraud within the payroll process.
- Monitoring for Internal Fraud Indicators
Stay vigilant by monitoring for indicators of internal fraud. Look for red flags such as duplicate names, variations of the same name, duplicate bank accounts, or employees earning more than expected at their level. Regular audits and checks are vital components of a robust fraud detection system.
- Strengthening Fraud Detection Strategies
Regularly review and strengthen your fraud detection strategies. This might include employing external auditors, conducting spot checks, and using advanced payroll software to detect inconsistencies that could indicate fraudulent activities. Maintaining an up-to-date approach to payroll management and payroll security is key.
What steps can you take to eradicate the risk of payroll fraud?
- Detect and protect
An employer needs to protect their business from fraud. Even if a well-defined policy for protection against payroll fraud is in place, employers need to stay on the ball. Payroll fraud can take place undetected over a long period of time if procedures are not applied properly or reviewed periodically to make sure they remain fit for purpose.
- Make sure applicant information is reviewed
One important way of avoiding payroll fraud is to make sure there are no indicators of problems in an applicant’s history before you decide to employ them. Employers should thoroughly screen job applicants; follow up on a minimum of two references and conduct all necessary background checks to ascertain as far as possible that the candidate is making a genuine and honest application for the position.
- Separate processes
Having separate HR and Payroll departments can provide an extra layer of checks throughout the processes that could flag up instances of payroll fraud. A new employee’s details can be signed off by HR and sent to payroll so one department is responsible for authorising payment, while another is responsible for monitoring payments.
- Outsource your payroll
Payroll agencies that are approved by HMRC can provide a company with the confidence that its payroll will be handled in a secure way. An outsourced payroll substantially reduces the opportunities for any form of in-house fraud.
- Monitor payments and conduct self-audits
Regular auditing and monitoring of all payments is essential to stay on top of payroll fraud. External accounting firms are likely to spot inconsistencies that may otherwise go undetected.
If you are not in a position to hire an external auditor, do accounting spot checks. Look out for anomalies such as duplicate names or variations of the same name or duplicate bank accounts and take note of anything amiss e.g. an employee earning a higher salary than would be expected at their level within the company. Stay vigilant for any signs of activity that don’t seem consistent with business performance – rising commission payments despite a static sales performance for example.
- Update passwords
It goes without saying that any information that’s held digitally should be password protected…but it’s also vital that system passwords are frequently changed. Ideally, adopt a password policy for all employees, setting out the required standards.
- Maintain confidentiality
Make sure that your payroll department has all of the necessary support to maintain data security at all times. That includes very practical considerations, like not having to share printers with other departments in case confidential material is accidentally left out for all to see. Adopt a rigorous policy of locking physical employee payroll files away in a filing cabinet. Shred confidential information that is no longer needed. Even better, reduce the amount of paper associated with the payroll process by exploring the options that payroll software can offer for running the whole payroll.
Payroll fraud can become a serious problem, but by adopting a dual strategy of protection and detection you can safeguard your assets and keep your business fraud-free. If you would like to learn more about our secure outsourced payroll services, then please don’t hesitate to contact us.